GRAPHIC-Spain, Italy top euro zone debt returns in first quarter
* Spanish bonds top chart in terms of total returns
* Italy pips last year's best performer Ireland to 2nd place
* More gains seen on accommodative ECB, Japanese buying
By Emelia Sithole-Matarise
LONDON, March 31 (Reuters) - Spanish government bonds were the euro zone's top-performing debt in the first quarter, handsomely rewarding investors lured by government commitment to reforms and signs of economic revival as the debt crisis eases.
Running close behind were Italian bonds, pipping last year's star performer Ireland in terms of total returns. The three bond markets, hammered during the euro debt crisis, have outperformed top-rated debt so far this year, attracting investors deterred by ultra-low yields in major economies.
Spanish bonds have returned 5.75 percent so far this year, according to data compiled based on Markit's iBoxx EUR benchmark index, one of the most traded bond indexes by investors globally.
Italian debt returned 5.20 percent while bonds issued by Ireland, which became the first of the euro zone's troubled debtors to exit an international bailout in December, returned 4.34 percent after topping the returns chart for the last two years.
Junk-rated Portuguese and Greek bonds handed investors heftier returns than Spain, Italy and Ireland, as tensions in emerging markets triggered by the U.S. Federal Reserve trimming its stimulus scheme pushed some investors back into the 'peripheral' southern European markets they fled in panic three years ago.
Portugal and Greece are not part of Markit's iBoxx EUR benchmark index because their credit ratings are too low.
"The best trades in the first quarter have been to be long peripherals and long duration. Heading into the second quarter this should be sustained," said David Schnautz, a strategist at Commerzbank in New York.
The robust returns from Italian and Spanish bonds look set to extend into coming months as anticipation the European Central Bank will take extraordinary stimulus measures to fend off deflation holds down higher-rated bond yields.
At 0.5 percent in March, euro zone inflation was at its lowest since 2009, its sixth straight month in the ECB's "danger zone" below 1 percent.
Talk by some of the ECB's most conservative policymakers that asset purchases were not out of the question gave fresh impetus to the rally in euro zone bonds in recent weeks.
"Yields can decline more along the curve. The likes of Spain and Italy probably have another 25 basis points to go in the 10-year sector. We also remain upbeat further down the credit curve regarding Portugal," Schnautz said.
Some in the market, such as Citi strategists, expect buying from Japanese investors to pick up pace as the new financial year in Japan gets under way. Research by Citi shows Japanese investors were still short or very short all euro zone peripheral markets.
Although Spanish and Italian 10-year yields are now at their lowest in over eight years at 3.23 percent and 3.28 percent respectively, they still offer a yield pickup of around 170 bps over German Bunds.
Portuguese yields have also slid to four-year lows to trade around 4 percent, as investors bet it will end its bailout in May as smoothly as Ireland. (Graphics by Vincent Flasseur and Emelia Sithole-Matarise; Editing by Ruth Pitchford)