* Greek 10-year govt bonds return 15 pct in year to date
* Portugal consistent underperformer with negative returns
* Italian bond returns turn negative in Q4 on politics
* Graphic: reut.rs/2fOoOMc
By Dhara Ranasinghe and Alasdair Pal
LONDON, Dec 15 (Reuters) - Bailed-out Greece was the best performing euro zone government bond investment this year, while Portugal lost the most money for investors as fears about its banks, economy and credit rating conspired against bondholders.
Returns on Italian sovereign bonds, positive for much of 2016, turned negative during the fourth quarter on worries about the referendum on constitutional reform that led to the resignation of Matteo Renzi as prime minister.
But for holders of volatile Greek bonds, the rocky ride may have been worthwhile. Returns for benchmark 10-year government bonds were down 19 percent in February but are ending the year up roughly 15 percent, according to Thomson Reuters Datastream.
"There has been volatility but in terms of performance this year, it's been fantastic if you've had the appetite for Greece," said Padhraic Garvey, ING's global head of debt and rates strategy.
Greece, which also delivered positive returns in 2015 , is on its third international bailout since crisis first hit the indebted euro zone state in 2010.
It hopes a deal with its lenders on its latest bailout review will pave the way for inclusion in the European Central Bank's bond-buying stimulus programme early next year, allowing Greece to test markets with a debt issue later in 2017. Greece last issued bonds in 2014.
The European Stability Mechanism bailout fund said on Thursday, however, it had suspended measures aimed at cutting Greece's public debt, sending Greek yields to one-month highs. But analysts said they were not too concerned about the outlook for the bond market.
In contrast, Portuguese 10-year government bonds have lost around 8 percent so far this year and Italian peers have shed about 1 percent. reut.rs/2fOoOMc
Stronger economic growth globally, expectations of fiscal expansion under U.S. President-elect Donald Trump and rising oil prices have lifted inflation expectations, just as a perception grows that an era of ultra-loose monetary policy is coming to a close. The U.S. Federal Reserve delivered its first rate hike in a year on Wednesday and signalled a faster pace of increases in 2017.
Against this backdrop, government bond returns generally are expected to suffer. Portugal, viewed as one of the weakest links in the 19-member euro zone, remains vulnerable. There are also worries that Portugal may not benefit fully from an extension of the ECB's bond-buying scheme because the central bank may face a scarcity of elible Portuguese debt.
Portugal's 10-year borrowing costs have risen 134 basis points so far this year, set for their first yearly rise since the euro zone debt crisis in 2011.
Then country's banking sector remains weak, economic growth is modest and government debt at just under 130 percent of GDP is not expected to fall much next year.
A sell-off earlier this year on fears Portugal could lose its last investment grade rating -- from DBRS -- which it needs to qualify for the ECB's bond-buying programme, highlights just how sensitive investors are to the power of that backstop.
"One reason why we went more underweight on Portuguese debt was the idea that Portugal would not be as fiscally responsible as some had hoped a year ago -- especially when you compare it to other countries such as their neighbor Spain," said Ira Jersey, a fixed income strategist and portfolio manager at OppenheimerFunds.
Spain's 10-year bonds have returned 4.5 percent so far this year and top-rated German bonds returned 4 percent in the year to date. (Reporting by Dhara Ranasinghe; Graphic by Alasdair Pal, Editing by Jeremy Gaunt)