The Spain international was thrust into the heart of Real's midfield as a result of Modric's thigh injury - expected to keep the Croatian out for six months - but shone as the European champions ran out 4-0 winners in the Basque Country.
Isco has struggled to nail down a regular position in Real's team since moving from Malaga, but Ancelotti was quick to hail the 22-year-old's efforts.
"It has been a good game. We have played well and with a lot of concentration," the Italian said.
"Isco has shown that he can play in that position perfectly.
"We need to continue with the attitude that we have. It's a very long season.
"It has been a party for this town. We are happy. We have had a lot of fans out there cheering their team on. They showed great respect."
Isco played at the expense of Sami Khedira, who was once again linked with a January exit from the Santiago Bernabeu this week.
Ancelotti explained: "He was a little tired. I preferred to put Isco on who was fine and recovered after having played for Spain."
